Lockheed Martin Corporation — Q1 2019 Form 10-Q
Reporting period: Quarter ended March 31, 2019; comparative quarter ended March 25, 2018. Amounts are in U.S. dollars. The interim financial statements are unaudited and were reviewed by Ernst & Young LLP.
Business context
Lockheed Martin is a global security and aerospace company operating through Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space. The U.S. Government accounted for 70% of Q1 sales, international customers 29%, and U.S. commercial and other customers 1%. The F-35 represented approximately 26% of consolidated sales.
Financial results
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $14.336 billion | $11.635 billion | +23% |
| Gross profit | $2.188 billion | $1.658 billion | +32% |
| Operating profit | $2.283 billion | $1.725 billion | +32% |
| Earnings before taxes | $1.945 billion | $1.360 billion | +43% |
| Net earnings | $1.704 billion | $1.157 billion | +47% |
| Diluted EPS | $5.99 | $4.02 | +49% |
| Operating cash flow | $1.663 billion | $632 million | +$1.031 billion |
Consolidated gross margin was approximately 15.3% versus 14.3%; operating margin was approximately 15.9% versus 14.8%. The effective tax rate declined to 12.4% from 14.9%. EPS also benefited from a lower average share count following repurchases.
Sales increased across all segments: Aeronautics $5.584 billion (+27%), MFC $2.350 billion (+40%), RMS $3.762 billion (+17%), and Space $2.640 billion (+13%). Segment operating profit was $585 million, $417 million, $379 million, and $334 million, respectively. Segment operating margins were 10.5%, 17.7%, 10.1%, and 12.7%, respectively.
Cash, debt and liquidity
Cash and cash equivalents were $991 million at quarter-end, up from $772 million at year-end 2018. Operating cash flow of $1.663 billion was offset by $257 million used in investing and $1.187 billion used in financing, leaving a net cash increase of $219 million. Capital expenditures were $284 million; dividends paid were $638 million; and $281 million of common stock was repurchased in cash flows (the quarter’s total repurchase cost was $284 million).
Current assets were $18.031 billion and current liabilities $15.403 billion. Long-term debt, net, was $12.621 billion; current maturities and commercial paper totaled $1.300 billion. The company reported $13.9 billion of debt net of unamortized discounts and issuance costs, and $15.1 billion of outstanding debt and commercial paper principal. A $2.5 billion revolving credit facility was undrawn, and the company reported compliance with debt covenants. Contract assets rose to $10.497 billion from $9.472 billion, while contract liabilities increased to $6.796 billion from $6.491 billion.
Material changes and unusual items
- Growth was led by higher F-35 production and sustainment, missile programs, and RMS systems and helicopter volume. Segment operating profit also benefited from higher volume and contract risk retirements.
- Net adjustments unrelated to volume, including profit-booking-rate adjustments and other matters, increased segment operating profit by approximately $565 million, or $1.57 per diluted share after tax, versus $420 million, or $1.15 per share, a year earlier. Revenue recognized for performance obligations satisfied in prior periods was approximately $670 million, compared with $415 million.
- Q1 included a $50 million charge ($38 million after tax) for a ground-based radar program; cumulative program losses were approximately $195 million. Commercial satellite programs recorded $20 million of additional losses, with cumulative losses of approximately $410 million. The Warrior turret program’s cumulative losses remained approximately $140 million.
- Other income included a previously deferred, noncash $51 million property-sale gain. The lower tax rate included an approximately $65 million, or $0.23 per share, discrete benefit related to prior-year foreign-derived intangible income treatment for foreign military sales.
- Operating cash flow was substantially higher year over year, mainly because Q1 2018 included a $1.5 billion pension contribution and higher working-capital use in Q1 2018; prior-year cash flow also benefited from approximately $850 million in net tax refunds.
- Adoption of the new lease standard resulted in recognition of approximately $969 million in operating lease assets and $1.1 billion in lease liabilities at March 31, 2019; management reported no material effect on operating results or cash flows.
Outlook, commentary and risks
Management expected 2019 sales to increase in the mid-single-digit range from 2018, business-segment operating margin to be approximately 10.7%, and cash from operations to be at least $7.5 billion. The outlook assumed continued U.S. Government support and funding of key programs. Segment outlook: Aeronautics sales and operating profit up high single digits, with comparable margins; MFC sales and profit up low double digits, with slightly lower margins; RMS sales and profit up low single digits, with slightly higher margins; Space sales up low single digits, but profit down mid- to high-single digits and margin lower, principally due to lower expected equity earnings.
Backlog was $133.5 billion; management expected to recognize approximately 37% as revenue within 12 months and 65% within 24 months. Q1 F-35 deliveries were 26 aircraft; 383 production aircraft had been delivered and 370 remained in backlog. Management cited continuing F-35 oversight and risks involving suppliers, software, sustainment costs, funding, testing, schedule, and requirements.
Key risks include U.S. defense-budget uncertainty and statutory spending limits after FY 2019, possible sequestration, continuing resolutions or shutdowns, dependence on government contracts, export approvals and restrictions, contract execution and cost estimates, and legal and environmental contingencies. The third commercial satellite remained behind its delivery schedule; further technical or schedule problems could trigger additional losses, and failure to meet the contract termination date could expose the company to repayment and penalties. Management stated it did not consider customer termination probable. Sikorsky goodwill and intangible assets were identified as potentially vulnerable to impairment if projected cash flows or market assumptions deteriorate.
Contingencies include a False Claims Act matter concerning a Navy support contract, with the U.S. Government seeking approximately $52 million in damages subject to trebling and statutory penalties; a separate DOE-related DOJ action with unspecified damages and potential indemnity exposure; and the MTA dispute, in which the MTA seeks approximately $190 million while Lockheed Martin asserts approximately $95 million in claims. Environmental liabilities were $830 million and related recovery receivables $721 million; the company noted that stricter standards for certain contaminants could increase estimates. Management said it did not believe the disclosed legal matters were probable to cause a material adverse effect on the company as a whole, while acknowledging possible period-specific effects.
Important facts for investors to verify
- Whether 2019 sales, segment margin, and operating cash-flow guidance was achieved, and whether government funding supported key programs.
- How much of the elevated profit and EPS reflected contract estimate changes, risk retirements, the discrete tax benefit, and the property-sale gain, and whether these items recur.
- Progress, cost-to-complete estimates, delivery timing, and potential additional charges for the ground-based radar, satellite, and Warrior turret programs.
- Cash conversion and working-capital trends, particularly the growth in contract assets; debt maturities, commercial paper usage, dividends, and repurchases.
- Developments in the cited legal proceedings, environmental recoverability and liabilities, and potential impairment indicators for Sikorsky goodwill and intangibles.